China Knows a Slowdown Has Begun. Rest of the World Will Find out Soon

China is the world’s second-largest economy, after the U.S., and represents almost 16% of global GDP. This means that if Chinese growth of 6.7% slows down by 0.5 percentage points, global growth will slow 0.25 percentage points. That’s huge considering global growth is only about 3.5% to begin with.

That kind of slowdown does not take into account the spillover effects on other countries such as Australia and South Korea, which could be huge as well. From an economics perspective, what happens in China does not stay in China. China is facing a menu of choices, all of them bad.

China is struggling under a highly unstable mountain of debt — much of it unpayable — in the form of corporate bonds issued by insolvent state-owned enterprises, Ponzi-like wealth management products and zombie bank balance sheets.

China could take an extreme approach to write-offs and bail out the system with part of its $3 trillion in reserves, but that would cause a recession and social unrest. China could ignore the problem, which will result in a “lost decade” similar to Japan after 1989 or the U.S. after 2008.

Oras this article describes, China could try a targeted regulatory approach. The problem with regulation is that it presupposes the government will get everything right (which it won’t). That could result in unintended instability (in contrast with the intended radical approach in the first option).

All three approaches mean slower growth at best and a recession or panic at worst. These scenarios are not yet priced into global markets. They will be soon.